So you’ve made a budget and now you’re starting to save. What should you do with the money?

  • Credit Card debt
  • Emergency Fund (one month of expenses)
  • Other Non-Mortgage Debt (car loan, student loans)
  • Some Retirement Saving (get employer match)
  • Future Big Purchases (house, trip, car, kid college)
  • More Retirement Saving
  • Audacious Goals: House Payoff, Early Retirement, Year off from Work, …

First, if you have any credit card debt, pay it off. Put the credit cards away so you stop using them. Pay with a debit card instead. I know, debit cards don’t have rewards and fraud protection. But if you’re in debt, stopping the bank from taking your money every month in interest matters much more than the value of credit card rewards and the potential risk of losing some to fraud.

Once your credit cards are paid off, the interest you were paying is now free for other saving. If your “monthly bills” account included minimum credit card payments, that money can go to other goals now. Since “monthly bills” aren’t paid from your day-to-day checking account, the new savings won’t disappear into other spending.

Next, start building up an emergency fund. Even if your month-to-month spending is manageable, surprises and emergencies will happen. Maybe your car breaks down, your roof starts leaking, or you get injured and have medical costs to cover. Your goal is to save up money to handle these kinds of situations without getting back into credit card debt. Having just one month of expenses saved up provides a huge boost to peace of mind, knowing that you can handle a surprise bill or manage if you lose your job without immediate disaster. Make sure to keep your new emergency money in a bank account you can easily access, because the point of the money is to be available instantly when you need it.

After you’ve saved one month of expenses, I would suggest shifting most, but not all, of your saving to your next goals. Many people recommend saving six months of expenses in emergency money, but that takes a very long time and money set aside for later goals can often be repurposed as emergency money if needed.

With credit card debt gone and an emergency fund, it’s time to wipe out your other non-mortgage debt. If you have car loan or student loan, start allocating some of your money to pay those down. Once you pay off your current car, put your car payment money toward other debt, then accumulate it so that you can buy your next car without a loan.

Now that any debt other than your house is out of the way, it’s a good time to start some retirement savings. If your job offers a 401(k), saving money for retirement will reduce your taxes. Many companies also offer to match some of your savings, providing a huge boost. You can also save pre-tax money for retirement in an IRA (individual retirement account) on your own. Try to save enough to maximize any matches, or about 5% of your income even if there aren’t any matches available.

Along with some initial retirement savings, you can start thinking about future big purchases. If you know you’ll want to buy a house, pay for college for kids, take a big trip, buy a fancier car, or make another big purchase in the next few years, start saving for those goals. Retirement saving is important for your future, but the point of saving is to help your present as well. Having some big spending goals you can achieve makes the benefits of saving feel a lot more real.

If you’ve paid off all of your debt, are making steady progress toward any big purchases, and still have money left, congratulations! It’s a great feeling. At this point you can work toward some truly audacious goals like early retirement, paying off your house, saving for a year off from work, and other things that most people aren’t able to do. If you ramp up retirement savings, take the time to estimate how much you’ll need for retirement. (More on that in a future topic). Retirement savings have no tangible, day-to-day benefit, so calculating how much your extra saving will increase your future lifestyle or allow you to retire sooner is really important to help keep you motivated.